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3 Scorching-Hot Oil Stocks -- Are They Buys?

Encana, Devon Energy, and Marathon Oil are up more than 15% over the past three months.

Crude oil has rallied without much fanfare over the past several months, recently notching gains of more than 20% off the bottom to set off a new bull market. That rebound in crude prices has taken several oil stocks up with it, including Encana(NYSE:ECA), Devon Energy(NYSE:DVN), and Marathon Oil(NYSE:MRO), which have been blistering hot over the past three months. Yet all three appear to have much more upside in the coming years because of their growth potential at current oil prices, which makes them great buys for oil bulls.

That ambitious plan is starting to look a bit conservative

After spending the bulk of the oil downturn repositioning its portfolio and driving out costs, Encana returned to growth mode last fall, unveiling a new five-year plan to boost output and cash flow. That forecast put the company on pace to increase production and cash flow by 60% and 300%, respectively, by 2021. Furthermore, the company believed it could achieve that ambitious growth plan while living within cash flow as long as crude averaged $55 per barrel.

Image source: Getty Images.

However, thanks to impressive well performance and continued innovation, Encana is already well ahead of that pace. In fact, the company now estimates that it needs oil to average only $50 a barrel to fuel that plan within cash flow. Given that lower breakeven level, and the growing view that crude could have much further to run, there appears to be plenty of upside potential left for Encana investors, even after its 32% run-up over the last three months.

Just starting to reaccelerate

Like Encana, Devon Energy also spent the bulk of the oil market downturn reshuffling its portfolio and driving down expenses. Therefore, it, too, was able to return to growth mode this year, with plans to boost its oil output 13% to 17% by the end of this year and by 20% more in 2018. Thanks to remarkably robust well performance this year, Devon now expects its oil output to be up 18% to 23% by the end of 2017. It can achieve that higher rate even though it cut $100 million from its budget because of efficiency gains.

That trajectory sets the company up for a strong showing in 2018 and beyond. While the company has yet to put out a long-term oil growth forecast, it controls a stunning 30,000 potential drilling locations in the oil-rich Delaware Basin and STACK play, which gives it a multi-decade growth platform. Given the returns it can earn on those wells, Devon can deliver a high rate of growth in the current environment, which it can quickly accelerate as crude moves higher. So while the stock is up 17% in the past three months, it should still have ample upside from here even if crude doesn't go any higher.

Image source: Getty Images.

Repositioned to thrive

Marathon Oil's story is nearly a mirror image of Encana and Devon. It, too, has jettisoned lower-margin assets and replaced them with large-scale positions across some of America's top shale plays. Further, it has cut costs through efficiency gains and other means, with its production costs down 40% since oil peaked in 2014.

This transformation has positioned Marathon Oil to start growing again. The company expects production to be up 7% this year after adjusting for assets sales, fueled by 23% to 27% higher output by year-end from its U.S. resource plays. Meanwhile, the company anticipates that those shale positions will enable it to increase production by a 10% to 12% compound annual growth rate through 2021. Furthermore, like Encana, it can achieve that forecast within cash flow -- including paying its dividend -- at just $50 oil. Because of that ability to increase output at a rapid rate around current crude prices, there should still be plenty of gains ahead for Marathon investors, even after its 18% jump in the past three months.

High returns at current prices with a potential gusher if crude keeps rising

Despite their recent rapid ascents, all three of these oil stocks are down this year, with Encana slipping nearly 5% while Marathon and Devon have declined more than 20%. Those slides came even as all three companies are thriving in the current market environment, and they should continue to do so even if crude remains low. Meanwhile, because each can grow production and cash flow at such a rapid rate near current oil prices, it suggests that they could expand both even faster if crude heads higher. Given that upside potential, oil bulls will want to consider owning one of these top-tier shale stocks.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Author

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries: Follow @matthewdilallo